Securities lending and borrowing (SLB), also known as stock lending and borrowing, is a system through which investors can borrow or lend securities (shares, bonds, and notes) to other buyers or sellers (market participants, in other words) who deal in securities and commodities in a structured market. This trading practice is generally more popular among experienced traders who prefer taking bigger risks than usual.
What is security lending and borrowing?
Let us first understand what ‘securities’ stand for. In UAE, the term ‘securities’ means the shares, bonds, and notes issued by joint-stock companies, bonds and notes issued by the Federal Government or Local Governments, public authorities and public institutions, and any other domestic or non-domestic financial instruments recognized by UAE Securities and Commodities Authority.
Security lending and borrowing is a legitimately endorsed mechanism for loaning and gaining securities. Through SLB, investors with inert securities can acquire great returns on the off chance that they loan these assets to merchants who want to participate in a backward exchange or to those who are simply low on stocks. SLB is a more feasible alternative to the marketplace for stocks, bonds, commodities, and other assets for hedging.
Now, you might wonder what are ‘Borrowers’ and ‘Lenders’? In SLB, borrowers are usually merchants who want to sell the securities that they don’t possess. On the contrary, lenders are those financial specialists who have purchased the securities for long haul purposes but those are not being utilized and are lying inert in their Demat accounts. In general, a borrower is a person who anticipates that the costs of the stocks will dive in the immediate future. The lender is an individual with a high net worth who has no immediate plans to clear his possessions.
Now, an individual with a high net worth would not like to trade his stock. He accepts that his present position will give him good returns in a long term. Nevertheless, this doesn’t imply that his stocks and assets must be an inert resource with no momentary returns. He can initiate the procuring capability of his stocks by loaning them to a broker and charge a financing cost or an interest. This loan fee is also alluded to as a premium.
On the contrary, the borrowing party intends to capitalize on the expected decline in the value of the stocks and get financial benefits. For this purpose, he will participate in a practice called short selling. Short selling (or short position) and long position are trading practices of dealing in stocks. A merchant takes a long situation in a monetary resource when he is of the opinion that its worth will go up. Conversely, a trader may take a short position if he can ascertain that the stock’s worth is going to devalue.
What are the benefits of SLB?
Security lending and borrowing have many benefits. Some of the general advantages are listed below:
- It encourages market proficiency as well as liquidity and diminishes market unpredictability by decreasing the spread of the offer (or bid) and expanding the profundity of the offer.
- It permits value revelation and the hedged exchange of pricing shortcomings.
- SLB underpins the improvement of the financial business sectors by encouraging different methodologies of investment and venture.
- It can also be utilized to fail coverage to guarantee trouble-free settlement cycles.
As a lender, you can get a gradual profit for an inactive portfolio from SLB. For example, in the event that a party or an individual has 1000 shares of something, which is to be kept for the long haul; they could be loaned at any point in time when demand is generated. As a lender, you will get loaning fees.
A borrower will observe an arbitrage in the price of the stocks between 2 trades, or switch exchange when prospects are at a markdown in order to stock, cover short selling to steer clear of settlement disappointment, mispricing in choices, and other Futures and Options arbitrage or hedging systems for which you need to have stocks. In a situation like this, stocks could be acquired from a lending party (or an individual) for a fee utilizing the practice of SLB.
Security lending and borrowing rules in the UAE
Security lending and borrowing transactions are executed in the Dubai Financial Market (DFM). The primary parties in a DFM SLB deal incorporate the lender, the lending agent, the borrowing agent, the borrower, the agent leader, and the Central Securities Depository (CSD) of DFM. CSD oversees the matching and settlement of SLB transactions by moving lent securities between the lender and borrower. It is also responsible for recording all SLB exchanges and transferring insurance which is DFM listed securities. It is mandatory for the lender and borrower to be DFM investors and have a DFM Investor Number (NIN). Any investor that is in possession of a DFM Investor Number (NIN) either legitimately with DFM or by implication with a local overseer will be qualified to become a lender or a borrower. Agent leaders are overseas negotiators who loan securities for customers who are lenders, and they preside over the loaning of securities for lenders. The borrowing agent and the lending agent supervise the transaction and dictate the CSD to transfer loaned securities and any appropriate insurance which are DFM listed securities according to the guidelines from the lender and the borrower.
DFM has laid out the rules which have to be followed for a successful SLB transaction. A summary of the rules and regulations is given below:
- Registration: A lending and borrowing agent is required to register with the DFM given that the lender and borrower have been affirmed according to the SLB guidelines. Any registration cycle must also comply with guidelines, booklets, rules, or methodology as endorsed by the DFM.
- Notification about the transaction: The lender is required to notify the lending agent to move the securities from the lender to the borrower according to the market rules that are issued periodically. Likewise, a borrower has to notify the borrowing agent to instigate a borrow request every once in a while for the exchange of securities from the lender to the borrower.
- Overseas and local SLB transactions: The lending and borrowing agents will be dictated by the lender and borrower whenever the need will emerge to transfer loaned securities to settle any overseas SLB transactions. Only lending and borrowing agents will be approved to conduct any local SLB transactions while complying with all market operational and administrative prerequisites endorsed under the SCA regulations.
- Market purpose and approaches: The DFM may endorse the purpose of borrowing the securities along with the SLB regulations and the SLB transaction will not be allowed for a purpose other than that as recommended in the market approaches. Assigned SLB accounts can be given for a borrower under the market approach. The exchange of acquired securities is strictly restricted unless allowed otherwise in the market approaches issued periodically.
- Charges: The endorsed charges by the DFM or any pertinent charges must be paid by the lender and/or borrower periodically and will be gathered by the lending and borrowing agents. The DFM is entitled to change the charges/fees now and then.
- Penalties: The DFM is authorized to reverse or close an SLB transaction in case the SCA guides the market to do so. An exchange like that can also be removed by the DFM as per the law or any administration policy mandate. The market will also be qualified to implement the reversal or closing of an SLB transaction in case such a move (reversal or closing) seems inconceivable because of the lacking securities with the borrower. In case of non-compliance with the DFM rules, the lending and borrowing party will be suspended by the market from creating new instructions for the lending of securities.
If you wish to go through the rules and regulations of securities lending and borrowing in detail, make sure to read the securities lending and borrowing regulations document on the DFM official website.
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